My favorite part of a Zumiez’s conference call is when CEO Rick Brooks apparently decides the analyst has asked the wrong question or doesn’t quite understand the implications of what’s been asked. Two plus pages of transcript later, sometimes ably supported by CFO Chris Work, we may have forgotten the original question, but we’ve always learned something new and intriguing.

So it was for the recent call discussing the quarter and year ended February 3rd, 2018. But before we have that fun, let’s go through the numbers.

The Numbers

Fourth quarter revenues rose 16.9% from $263.6 to $308.2 million. “Contributing to this increase were positive comparable sales growth of 7.5%, the net addition of 13 stores since the end of last year’s fourth quarter, the 53rd week in 2017 were $10.3 million and the positive impact of foreign exchange were at $5.3 million. Also benefiting fourth quarter 2017 net sales is an adjustment to deferred revenue related to our STASH loyalty program were $3.8 million,” explained CFO Chris Work.

The gross margin rose 1.5% to $37.2% compared to last year’s fourth quarter. Chris notes, “The increase was primarily driven by 120 basis points of leverage in occupancy, 80 basis points related to the recognition of deferred revenue due to changes in our STASH loyalty program, estimated redemption rate, and 70 basis points of improvement in product margins. These increases were partially offset by 70 basis point increase in inventory shrinkage and 20 basis point increase in incentive compensation. Inventory shrinkage has been difficult for us in 2017.”

I’d say it has been. When your improved product margin is 100% eaten up by disappearing inventory, it’s a problem. Zumiez has always tried to drive responsibility down to the store level. Remember that a year or two ago, they transferred responsibility for online sales to their stores? I’m wondering if that isn’t somehow related to the shrinkage problem.

SG&A as a percentage of sales for the quarter rose just slightly from 25% to 25.2%. “The…increase was primarily driven by 100 basis point increase related to our annual incentive compensation partially offset by 40 basis points of leverage in our store operating cost and 30 basis points of leverage across other corporate costs.” I never mind seeing incentive compensation expense rise, as it’s indicative of good results.

Net income for the quarter rose 9.6% from $18.2 to $19.9 million. For some perspective, the chart below shows the quarterly results for the last two years.

Zumiez ended its year with 698 stores; 607 in the U.S., 50 in Canada, 34 in Europe, and 7 in Australia. The number of new store openings, especially in the U.S., is declining. But Zumiez has been telling us that would happen for some years. Over the last three years, stores opened has declined from 57 to 28 to 17. The 2016 number of 28 was impacted by the acquisition of five stores in Australia. The estimated number for this fiscal year is 13 new stores worldwide.

The chart below shows the composition of sales by category during the last two years.

It’s always intrigued me to see how much revenue is from men’s’ apparel compared to women’s. It seems unusual for a mall-based retailer (if I can still classify Zumiez that way?). I don’t know if it’s a problem, an opportunity, or a competitive advantage. Also note the decline in hard goods as a percentage of revenues- takes up a lot of room but doesn’t offer great margins. But it’s an important part of Zumiez’s market positioning.

For the whole year, revenues roses 10.9% from $836 to $927 million. Sales in the U.S. were $774 million, or 83.5% of the total. In fiscal 2016, they were $711 million, or 85% of the total. “The increase reflected a $48.6 million increase due to comparable sales and a $23.6 million increase due to the net addition of 13 stores (made up of 12 new stores in North America, 5 new stores in Europe, and 2 new stores in Australia offset by 6 store closures). Net sales include $10.3 million related to the additional week in the 53-week period and a $6.3 million increase due to changes in foreign currency rates.”

Zumiez’s business in Europe has not performed as management hoped. They’ve had some losses there. As Chris put it, “…we have not had the results from the investment we’re hoping [for].” Rick Brooks talks about the “amazing results” they had in 2015 driven by a “…really huge long board trend and then in 2016 it basically completely reversed and of course we were still playing out as Chris said investing and building the business at that point when sales actually went – got considerably more difficult relative to what we assumed to be appropriate pace of growth at that point.”

By 2015, most of us were amazed the long board market hadn’t cracked already, but none of us had any doubt it was going to. Because that’s what bubbles do. If Zumiez was looking at success with their European acquisition that they could see was overly reliant on one product category, perhaps they could have called it out. But who want to sound a note of caution on a new (second half 2012) acquisition you paid a hefty price for.

Zumiez launched “…over 150 new brands…” during the fiscal year. It was just last year they were saying they tended to launch 100 a year. These are not Zumiez owned brands, but brands where Zumiez works with the owner at various levels to launch them in Zumiez stores.

The gross margin rose to 33.4% from 32.9% the previous year. “The increase was primarily driven by an 80 basis point impact due to leveraging of our store occupancy costs, 30 basis points related to the recognition of deferred revenue due to changes in our STASH loyalty program estimated redemption rate and 20 basis points on product margin. These were partially offset by 60 basis points in higher inventory shrinkage and 10 basis points due to higher annual incentive compensation.”

Net income rose 3.5% from $25.9 to $26.8 million.

There’s no need to discuss the strong balance sheet, except to remind you of the competitive advantage it offers, allowing you to pursue your strategy and initiatives even in the face of a bump in the road.

One last financial note before we get to the fun stuff. Zumiez 10-K includes the following risk factor: “The reduction of total outstanding shares through the execution of a share repurchase program of common stock may increase the risk that a group of shareholders could form a group to become a controlling shareholder.” It’s last in a list of many risk factors.

Companies, as you know, have been buying back their shares to boost their earnings per share. Some (not Zumiez) have been borrowing money to do it and leveraging up their balance sheets. We’ll see how that works out as interest rates rise.

Share buy backs are inevitably touted as a benefit to shareholders though you might also view buy backs as an admission by management that they can’t figure out any good investment opportunities in their business. I find it amusing that this benefit requires a risk factor in the 10-K. You might also consider that if the buy backs reliably raised the share price consistent with the reduction in shares outstanding, the cost to a potential controlling shareholder, in dollar terms, doesn’t change. If that were the case, I don’t think a risk factor would be required.

Tales from the Conference Call

Now for the fun stuff. I’m not going to start by reviewing Zumiez’s Competitive Strengths. They are the same they’ve been for 20 plus years and, most importantly, work in any retail environment. Instead, I want to remind you of two issues I’ve written about- not just related to Zumiez.

I’ve characterized the term “omni-channel” as the authoritative sounding word legacy brick and mortar retailers have used to make it sound like they’ve got things under control and know how to manage the brave new retail world where the consumer is in charge. I’ve also stated that doing ecommerce right is a continuingly expensive undertaking. Unless you can generate enough incremental revenue and operating income to at least pay for it, you are failing.

Being online- selling on line- having web sites and connecting ecommerce with brick and mortar do not represent a strategy. They are the necessary tools for implementing a strategy.

“We believe now we’re entering into a new phase in servicing our customer,” says CEO Brooks, “moving beyond omnichannel into a new consumer environment with yet higher expectations. While we’re not sure what to call this new consumer phase, the New World will be characterized by key themes and words, such as trade area, localization, optimization, speed, intimacy, engagement, connection, innovation, and community.”

I’m relieved I’m not the only one who doesn’t know what to call it. If Rick’s descriptors of the consumer environment are reasonably accurate, or at least not too far off from what the future holds, they are the basis for a strategy using the tools Zumiez has in place or is developing. If forced to reduce his already short list of words, I come down to flexibility and informational immediacy. Let’s talk about some things Zumiez is doing to succeed in the world Rick is describing.

As you know, Zumiez introduced 150 brands in fiscal 2017, up from around 100 the previous year. At this point, I imagine Zumiez has a robust system for onboarding, and offboarding when they don’t work out, new brands. In the environment Rick describes, imagine the value of seeing these new brands and the trends they may, or may not, represent when they are still small and, for lack of a better word, pure. How else does a retailer find enough new brands to satisfy the consumers’ requirement for constant newness?

Zumiez’s largest third-party brand accounted for 8.5% of revenues in 2017. That’s up from the previous two years. Meanwhile, Zumiez’s private label revenues have fallen over three years from 21% of revenues to 20.2% and 16.8% in 2017. Given the emerging competitive environment, I wonder if the Zumiez management team might not be conflicted if private label (regardless of the margin) grew too much or a single brand became a larger chunk of total third-party revenues.

Obviously, Zumiez’s size and resulting ability to support the new brand process gives it an advantage. Here’s how they describe it in the 10-K. “Given our scale and market position, we believe that many of our key vendors view us as an important retail partner. This position helps ensure our ability to procure a relevant product assortment and quickly respond to the changing fashion interests of our customers. Additionally, we believe we are presented with a greater variety of products and styles by some of our vendors, as well as certain specially designed items that we exclusively distribute.”

Zumiez’s new brand process isn’t restricted to the market the brand originated in. Says Rick, “…we have brands as well as trends that are already flowing across the oceans for us and working on multiple continents.”

Finally, Ricks longest answer to a short question highlighted another Zumiez’s advantage I, I’m embarrassed to say, hadn’t focused on before. You know that Zumiez has trade areas, and the goal is to maximize revenue from that area, not just to open new stores in it. You might find yourself closing stores to grow revenue. You also know that Zumiez has transferred ecommerce fulfillment to their stores. I always thought that was a great marketing/customer relations thing to do.

“Lever our physical store cost structure.” Just a few little words. Where the hell has my mind been! Zumiez is in the process of solving the problem of making the cost of the “omnichannel” pay off. By having fulfillment done through the stores they’ve made what used to be two cost centers into one and made that one more efficient. Completely in sync with their customers, Zumiez literally doesn’t even have to think about whether it’s an ecommerce or a brick and mortar sale. They don’t care because there’s largely just one cost structure. Rick continues:

“…this is one of the measures of what you mean when you say you have an integrated seamless experience right, you have to integrate it into everything you do in the service of customers. And of course our store teams and digital sales teams they all work as an integrated unit now, looking at all the touch points and how we can best drive consumers to whatever channel the empowered consumer prefers.”

“Probably the easiest example, Sharon, I could give you of evidence here about this idea of how we’d recreated this kind of new integrated business model is localized fulfillment. So through localized fulfillment and in particular already our order routing algorithms, we’ve now levered store payroll and our other store cost structures in two successive holiday seasons. And when I hear a lot of retailers talk, they talk about how a significant growth in web revenue is de-leveraging their business.”

Brick and mortar retailers were initially dragged into ecommerce as a defensive measure focused on giving their customers what they wanted. Zumiez has said that with their trade areas, new systems, and brick and mortar responsibility for ecommerce, they have figured out how to synchronize market and financial imperatives.

Can you make ecommerce a competitive positive if you don’t do that? I’m guessing no and expect all successful retailers with a brick and mortar footprint to have to do the same as Zumiez.

Zumiez increased revenues and profits in their October 29 quarter compared to the same quarter last year. The more interesting strategic question is how (if a single quarter is indicative of longer terms trends) and I’d like to highlight three factors that I see working together, though they are typically discussed separately.

During the quarter, Zumiez increased its sales and reduced its loss compared to the same quarter last year. It continued to follow its strategy and its balance sheet remains solid- perhaps a bit stronger than a year ago.

I’ve generally been a supporter of Zumiez’s strategy. It’s not that they necessarily know any better than any other retailer how things are going to shake out as retail consolidation winds its way through the industry, or that they are certain how, exactly, brick and mortar and online are going to evolve and influence each other. But they’ve made a couple of bets (that we’ve been talking about for some quarters bordering on years now) that are complementary to their long-term strengths and strategies and that offer them the data and flexibility to respond when, inevitably, things don’t turn out exactly as they expect.

The conference calls get shorter and shorter as Wall Street and its analysts decide the retail sector just isn’t worth their attention. I don’t and won’t invest in anything I write about but damn, this feels like one piece of putting in a bottom in the retail sector. Maybe it will take the recession to finish the process.

Zumiez had a quarter which I’ll describe as uninspiring. Like every other industry retailer, they find themselves in circumstances of declining mall traffic, sluggish demand and an uncertain future that changes faster than you can react to it.

Zumiez has been telling us for some time now, correctly I think, that they are approaching the number of Zumiez stores the U.S. market can support. They ended their January 31 year with 603 U.S. stores. No doubt they will continue to selectively open (and close) stores and there is certainly no exact number of stores this market will support. However, I’m guessing that the number has declined due to a weak economy, an over retailed market, and Zumiez’s omnichannel influenced “trade area” strategy.

That strategy focuses on having the right number of stores in each geographic area given ecommerce and the way Zumiez’s customers are choosing to shop. Its focus is maximizing revenue in each area. Its premise is that opening more stores isn’t the only, or even the best, way to do that.

But Zumiez is a public company. Growth matters, though CEO Rick Brooks (along with some other CEOs) is trying to get the Wall Street community to focus a bit more on the bottom line rather than the top.

I guess after the initial shock you get when something new and different happens, I wasn’t that surprised to see Zumiez’s new concept store WAYWARD open in this Bellevue, Washington mall two stores down from the Zumiez store. Here’s a picture of the entrance.

I’m always grateful when a company has a short 10K and conference call. I’m efficient at spotting the meat in a 10K, but it’s easier when it’s 77 pages, as Zumiez’s was, instead of 177 pages. Though when it’s 177 pages, there’s usually some really interesting stuff.

Zumiez doesn’t need more than 77 pages. They pursue the general strategy they’ve pursued since the company was founded, they make money, and their balance sheet is fine. They are dealing with the same crappy retail and economic environment everybody else is, they are impacted by it, and they are cautious about the future. Ho hum.

http://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gif00jeffhttp://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gifjeff2017-03-22 10:41:102017-05-02 08:18:51Zumiez’s Annual Report and Some Questions I’d Ask if I were an Analyst.

Zumiez’s 10-Q for its quarter ended October 31 reported an increase in sales and profits. I used the word “Too” in the article title because it sounds a bit like the Tilly’s results I reported a few days ago. Zumiez, like Tilly’s, would like to point to all the good things it’s doing as being responsible for the result. And no doubt it’s fair to do that, but Zumiez, like Tilly’s was surprised by the strength it’s seeing and is cautious as to whether it will continue.

Net sales rose 8.4% from $204.3 to $221.4 million. “The increase primarily reflected an increase in comparable sales of $8.2 million and the net addition of 35 stores (made up of 27 new stores in North America, 5 new stores in Europe, and 5 new stores in Australia partially offset by 1 store closure in North America and 1 store closure in Europe) subsequent to October 31, 2015. By region, North America sales increased $14.7 million or 7.8% and other international (which consists of Europe and Australia) sales increased $2.4 million or 14.6% for the three months ended October 29, 2016…”

http://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gif00jeffhttp://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gifjeff2016-12-15 11:51:462016-12-15 11:51:46Zumiez Has a Good Quarter Too

Zumiez is one of the public companies I follow that I hold up as doing most things right, but that doesn’t make them invulnerable to a tough economic environment.

Revenues for the quarter ended July 30 were down 0.86% from the same quarter ended last year on August 1. They declined from $179.8 to $178.3 million. The decline reflects an $8.7 million decline in comparable store sales (4.9%) offset by a net opening of 33 new stores. North American sales rose 0.2%- about $0.4 million. “…European sales decreased $1.2 million or 8.5% to $12.3 million.”

The gross profit margin fell from 32.1% to 30.8%. Product margin rose by 0.3%, but deleveraging of store occupancy costs (spreading more costs across lower revenues) cost them 1.3%.

SG&A expenses rose 6.7% from $52.5 to $55.9 million. As a percentage of sales they rose from 29.2% to 31.5%. This isn’t necessarily a completely bad thing, assuming some of the additional spending addresses their long term strategy. Some of it is also funding minimum wage increases.

That produced an operating loss of $1.1 million compared to an operating profit of $5.3 million in last year’s quarter. Net income fell from a profit of $3.2 million to a loss of $838,000. That includes an income tax expense of $1.98 in last year’s quarter compared to a tax benefit of $526,000 in this year’s.

I guess you can argue that the balance sheet, compared to a year ago, weakened a bit but not so that it matters. Cash and marketable securities fell from $80.7 to $57.3 million. During the year, they have bought $18.3 million of their own stock ($6.7 million in the just ended quarter).

Inventory rose slightly from $122 to $132 million. The current ratio fell from 2.43 to 2.05. Shareholders’ equity declined 8.2% from $305 to $280 million.

At July 30, Zumiez had 673 stores; 604 in the U.S., 44 in Canada and 25 in Europe. They are looking at opening 29 new stores in 2016 including six in Canada and seven in Europe.

During the conference call, they announced the August 31st completion of the acquisition of Australian retailer Fast Times. It operates five stores and a website. They paid $5.5 million (Australian) plus $1.4 million in Zumiez’s stock (also valued in Australian dollars I assume). In the 12 months ended June 30, Fast Times had revenue of AUD $9.2 million and had pretax margins of around 10%.

I assume the plan is to grow Fast Times stores in the same way we saw growth in European and Canadian stores once Zumiez got a foothold in those markets. Another thing I find interesting is that Zumiez is now operating in four currencies. It adds some complexity, but maybe also some opportunities as the Australian business grows.

Let’s start looking at strategy by recalling that Zumiez considers itself to have one distribution channel and doesn’t differentiate between online, mobile, and brick and mortar as they think about their market. As a result, they divide their business up into something they call trade areas.

What’s a trade area? I don’t think I’ve ever heard them define it publicly. No doubt it has a geographic component, but I don’t think it’s that simple. As I understand it (don’t want to be putting words in Zumiez’s mouth here), it is the “locus of connection” as defined by their customers and the way they choose to shop. It’s a moving target.

Wow, that sounds great! Unfortunately, I’m not completely sure what it means operationally, and I’m pretty sure Zumiez and other retailers are also still figuring it out. Before I get too far into the clouds here, which is a pretty good way to put it, I’m going to let Zumiez’s CEO Rick Brooks help bring me back to earth.

“Our strategy for new store openings remains the same. We’re committed to opening only those stores that are required to best serve our customers in any given trade area. Accordingly, and as we begin to approach our target for total mall store count in North America, our new store openings have slowed. Our focus has shifted towards optimization of the store base as we leverage our integrated structural and technological platform to maximize the impact each store has on its respective geographic region.”

Okay, “optimization of the store base.” What does that mean for these trade areas? Do you need fewer stores? For example, might you decide that a store with a $15 an hour minimum wage was too expensive to operate given that you have a store ten miles away where wages were $10 an hour and your customers were defining trade areas in such a way that they were willing to buy more on line? Does good management of a trade area mean you can generate more revenue at lower cost with fewer brick and mortar stores?

I wrote this article on minimum wage a week or so ago based on a comment Zumiez made in their conference call. I wanted to add that the additional company cost isn’t just the increase for those making less than minimum wage. Remember the people already making the new minimum wage or more are going to ask why they can’t get an increase as well. It’s a big number. Please recognize that I’m not arguing for or against increases in the minimum wage. I’m just pointing out, here and in the article, some possible impacts.

Next, let’s tie Zumiez’s idea of trade areas to the rollout of its new systems. As they’ve announced, they are rolling out the new “structural and technological platform” referred to above. They consider it an integral part of their strategy. To call it a point of sale or accounting system would miss the point.

You know that Zumiez has worked towards “hyper-localized merchandised assortments” and fulfilling all their online orders through their stores. Here’s how Rick describes the systems and their impact.

“Enhancements for making product delivery and our world class customer service are first and foremost aimed at augmenting our positioning and relevancy to our core customer base. Our efforts to-date are giving significantly faster delivery times for our online orders to our localized store fulfillment program. As we implement our customer engagements within North America, we’ll gain additional touch points for our customer, a faster, more integrated commerce platform and enhanced omni-channel functionality. This allowed us to further interact with our customers to facilitate alignment between our customers’ desires, our brand offerings and positioning.”

Zumiez considers itself a brand. It does not want to be defined by the brands it carries. It expects to sell brands at full price and margin. This, according to Rick is “…representative of brand strength, our Zumiez brand strength, meaning that our consumer sees value on what we are doing and is willing to pay full price.” It’s “…about having unique brands that are merchants in the marketplace, it reflects back to the comment we made about the strength of private label here performing well, and it also reflects back to the fact that we were down a little bit last year.”

They talk about brands emerging anywhere and how they “…quickly reach our niche consumers anywhere in the world through these mobile devices.”

“We want to be their local shop, but we want to be the local shop with global reach and global scale.”

How does this all come together? First, Zumiez is going to be completely agnostic about brands. They will carry those brands their customers want them to carry for as long as they can sell them for good margin. That shouldn’t be a new concept for any retailer, but I expect the speed of brand turnover to generally accelerate.

Rick has spoken in past conference calls about long term trends that have allowed them, in the past, to sell of a lot of specific style or category of merchandise. I wonder if he still expects those opportunities to return. Zumiez is certainly organizing itself as if it doesn’t expect that. Or perhaps it’s better to say they are organizing so it won’t matter if doesn’t happen.

Second, Zumiez doesn’t know what it’s going to find out when these new systems are all on line and generating data in ways they never been able to look at it before. What will they learn? What will they be able to do differently/better? The consumer is in charge. You’d better be able to react as quickly as they react and follow them to the new trends and brands before it changes again. Your systems are no longer a cost center. They are a critical element of your strategic advantage, if you can find one.

Third, notice the relationship between the brands that Zumiez carries and the strength of the Zumiez brand. They are reinforcing each other. This allows Zumiez to be successful in private label (and serve a customer looking for value and make a better margin) without damaging customer perception of the stores, as we’ve seen some other retailers do. Zumiez mentions in the conference call that they did something like 300 events at stores and other place last year.

Fourth, the new systems, the data they generate, and the flexibility they provide will be the engine that drives the concept of the trade areas. It will allow, as they said earlier, for “…optimization of the store base.” But I think it’s a mistake to assume they are just talking about brick and mortar stores here. It’s optimization of each trade area as they evolve, expand, correct, adjust. This is all going to be continuously in motion.

Finally, Zumiez has been very specific about who their customers are and that they want to sell the right brands (as defined by those customers) at full price and margin. This is very interesting to me. You know I think there’s a conflict between being achieving the growth a public company requires and differentiating and supporting your brand. It feels like Zumiez might be running up against this issue itself. If I read between the lines, I almost hear them telling the analysts that the biggest opportunity is at the bottom line- not the top.

You know, I’m just giddy over what Zumiez is doing because it’s what I think I’d do and I can’t wait to see how it works out. But we’re still an over retailed country and it’s becoming more costly to sell to a completely empowered consumer with less money to spend. I know there will always be brick and mortar retail, but I don’t know the form it will take and how much we need. Zumiez, and other established retailers, are stuck with a store base they can only change slowly and incrementally. New retailers are often starting only online and going from there.

I’ve generally been a supporter of Zumiez’s strategy and believe they’ve done most things right. So when I see them suffering right along with everybody else in a difficult (not nearly a strong enough word) retail environment, it really brings home to me just what we’re dealing with.

http://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gif00jeffhttp://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gifjeff2016-06-16 20:52:342016-06-27 08:13:45Preparing for Long Term Market Ambiguity; Zumiez’s April 30th Quarter

Like most industry retailers, Zumiez has been impacted by a slow growth economy, reduced and redirected spending on the part of its primary customer group, and the internet’s ability to make consumers powerful, product differentiation harder, and the brand cycle shorter. There’s no news there and nothing unique as far as its impact on Zumiez goes.

However, two issues came up in the report I want to spend a little time on. The first is Zumiez’s discussion of product cycles and their response to analysts’ questions on the subject. The second is the announcement that came out of the conference call that Zumiez would be opening fewer stores. They are related, and both represent the tip of the iceberg in terms of what Zumiez is trying to accomplish.

Let’s look at both of them, explore their interdependence, and figure out what I think Zumiez’s management is saying without exactly saying it. First, I’ll review the numbers just so you have them in mind as we get to the more interesting stuff.

http://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gif00jeffhttp://www.jeffharbaugh.com/wp-content/uploads/2014/08/logo_color_640.gifjeff2016-03-24 11:32:402016-03-24 11:39:29Zumiez’s Year and Quarter; What Are They Preparing For?

Consulting

Jeff Harbaugh has more than 20 years spent developing strategies to respond to changing market conditions, in-depth, objective knowledge of the action sports/outdoor/youth culture industry and skills to help you manage growth and make the transition from entrepreneur to manager.